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Some people manage investment portfolios professionally, and they use different strategies. One of them includes the tactical asset allocation that shifts the asset percentage in various categories. Most of the time, they do this when they believe that they can take advantage of robust market sectors or market pricing anomalies. Hence, it is a strategy that portfolio managers use to get more value when they see those market situations look like great opportunities. And we can say that it is an active to moderately active strategy because managers go back to the portfolio’s initial mix as soon as they reach the short-term profits they aim for.
Learning the basics
Learning the strategic asset allocation is a must to know how tactical asset allocation works. One way of setting the strategic asset mix of inclusion in the investor’s holding is if the manager makes an IPS or Investor Policy Statement. There are many factors that the manager will consider. Let us enumerate some of them:
- The required rate of return
- Acceptable risk levels
- Legal requirements
- Liquidity requirements
- Taxes
- Time horizon
- Unique investor circumstances
Strategic asset allocation
What is strategic asset allocation? It is the weight percentage of every asset class in the long run. The asset mix and weights immensely help investors meet their goals more manageable. Let us cite an example of a portfolio allocation with the weight of each asset class.
- Bonds= 50%
- Stocks= 30%
- Commodities= 10%
- Cash= 10%
Now, what is a tactical asset allocation?
Tactical asset allocation refers to a strategic asset allocation active stance and long-term target weights temporarily. Why temporarily? It is temporary because it only takes advantage of the market and economic opportunities that showed at the moment. Let assume that there will be more demand for commodities in the next six months while we also assume that it is what the data says. So, wouldn’t it make sense to allocate more on commodities for the next six months? It is what we mean when we say that it takes advantage of the temporary market or economic opportunities. The portfolio’s strategic allocation remains constant, but it will adjust for tactical allocation like this:
- Bonds= 50%
- Stocks= 30%
- Commodities= 15%
- Cash= 5%
The differences between rebalancing and tactical asset allocation
Some might confuse tactical asset allocation with rebalancing. It has an entirely different meaning, although we would not deny that they are similar in some ways. Rebalancing wants the portfolio to return to the preferred strategic allocation, which can be possible by making trades. On the other hand, tactical asset allocation temporarily adjusts the strategic asset allocation to make the most out of the current opportunities. Hence, the tactical allocation has plans to bring the strategic asset allocation back to the way it was once the opportunities are over.
Let us have a recap
TAA makes an active stance on the SAA and temporarily adjusts the long-term weight to make the most of the temporary market and economic opportunities. These shifts can also be possible within asset classes. An investor can adjust the asset allocation himself in a discretionary TAA. It will be according to the changes’ market valuation, similar to the market of the investment.
